China moves in on world resources

BP is the latest company targeted by Chinese sovereign wealth funds that are investing in natural resources around the world. And, unlike other countries, Britain is welcoming such investors with open arms. Stephen Foley reports

It was a neat coincidence that Alistair Darling, the Chancellor, was in Beijing yesterday for what was being billed as a China-UK "economic and financial dialogue". Because yesterday was the day that it emerged there has been a bit of dialogue going on between the Chinese government and BP, the jewel in the crown of the British oil industry. China's central bank, it seems, has amassed a £1bn stake in BP, giving it about 1 per cent of the company and underscoring, as if it were needed, the growing financial power of the Chinese state and the "sovereign wealth" that it is putting to work around the globe.

In many quarters in the West, the emergence of sovereign wealth funds (SWFs) from the developing nations of the Middle and Far East has been met with alarm, and by alarmist political rhetoric. In the US, for example, it is also being met with real political resistance, and even out-and-out protectionism.

But Mr Darling? Quite the opposite. "Our view is that investment from abroad, whether it's private sector or a sovereign wealth fund, is welcome, provided it is done on a commercial basis," he said.

BP, too, was gushing. "We are a publicly traded company and we welcome all shareholders," it said.

Mr Darling is, in fact, on a mission – inaugurated in January by Gordon Brown, when he visited China – to encourage the Communist government to set up an outpost of its SWFs in the City of London and to channel its investment activities through the UK's financial centre. He is not simply making nice for the sake of that deal (the Chinese Investment Corporation was reported in the local media to be hiring in London, but nothing has yet been signed in public) or even out of politeness to his hosts this week. Rather, the UK is charting a subtly different course from its US ally, and hoping to use the ferment of protectionist sentiment in the US as an opportunity to lure business away from New York.

"The UK's open and competitive market for international investment puts London in pole position to capture a growing share of this market over the coming years," says Marko Maslakovic, senior economist at the International Financial Services London, a lobby group. IFSL recently received funds from the UK government for a study of SWFs which calculated their assets grew 18 per cent in 2007 to $3.3 trillion, and that they would pass $5 trillion in 2010 on their way to $15 trillion in 2015. "We expect Asian governments' foreign exchange reserves to keep growing at the same pace as in recent years, but now they have all the reserves they need for monetary policy and we expect most additional reserves will go into sovereign wealth funds for investment abroad."

China alone is expected to have foreign exchange reserves of more than $2bn this year unless something totally unexpected happens to the level of its exports or it lets its currency appreciate dramatically. Mr Maslakovic concludes that, just as hedge funds lured to set up in the UK bring employment and contribute to the economy, SWF managers could do the same. In the US, many financiers have similarly positive conclusions about the emergence of SWFs. Stephen Schwarzman, chief executive of the private equity firm Blackstone, might have a particularly rosy view on the subject, since the Chinese Investment Corporation (CIC) handed over $3bn for a stake in his company last year, but he is also concerned about the economic consequences of protectionist responses to SWF investments in the US. Those responses – like the ones that scuppered a Chinese takeover of a small US oil producer, Unocal, in 2005, or a Dubai government takeover of US port operations in 2006 – have had a "chilling effect" on SWFs' willingness to make big investments in the US, he told a conference in New York this week, at a time when the US needs foreign investors to fund its balance of payments deficit.

Many US politicians, though, are not taking that line, and it is difficult to imagine too many making a placid, Darling-style response if it was ExxonMobil or Chevron that had emerged with the Chinese government on its shareholder register. To placate critics, even the free-trade Bush administration is considering reducing the threshold at which a foreign investment triggers an investigation as to its public interest. Currently, an investor has to take a stake of at least 10 per cent before it is subjected to scrutiny on Capitol Hill.

China's is among the sovereign wealth that has been poured into US financial institutions to shore them up after their sub-prime losses. Morgan Stanley, for example, took $5bn from CIC, giving the fund just under 10 per cent of the company in return. So far, these investments have attracted only limited political resistance, partly because of the 10 per cent threshold but mainly because the alternative might be a banking crisis in the US. These conditions won't apply for much longer.

The resistance to sovereign wealth investments is likely to be strongest if it comes into natural resources companies, for this is where suspicions about the motives of the Chinese and other governments has been most aroused. It is also where Mr Darling's caveat yesterday – investment is welcome "provided it is done on a commercial basis" – might yet become central, even in the UK.

The Chinese government argues that both CIC and the central bank managers investing foreign exchange reserves directly are doing so without political considerations playing a part. They are being prudent in diversifying their portfolios away from US Treasury bills, a traditional staple investment, and seeking out higher returns from other assets, such as blue-chip companies abroad. The question is whether they can guarantee that political considerations will never play a part (the Bush administration has been trying to broker a "code of conduct" that will improve the transparency of their investment processes).

Similarly, to what extent should Western governments resist handing over economic power because of the theoretical possibility that one day these stakes could be used to influence the flow of scarce natural resources towards fast-developing, energy-hungry China and away from other markets?

Other parts of the Chinese government are already making foreign investments for strategic reasons. The 9 per cent stake in Rio Tinto acquired by the state aluminium company in February was aimed at complicating a merger with BHP Billiton which would bring together two of the world's three largest iron ore producers and make it harder for China – the biggest importer – to keep prices under control.

Gerard Lyons, chief economist at Standard Chartered bank and a leading expert on SWFs, said in a recent panel discussion in Washington that funds' behavior is likely to be a mixture of commercial consideration and "state capitalism", where investments are likely to reinforce particular government goals, such as spurring the development of natural resources in Africa – already a key area of Chinese government investment. The limits of what is acceptable, he predicted, will be tested in the UK – and sooner rather than later.

"The UK economy is up for sale, and I think the whole question of ownership will be really tested in the next couple of years," he said. "We've only really had a problem in the Eighties when Kuwait was speculated to be buying BP, so we do protect sensitive and secure areas, but I think the debates will very much be tested out in my opinion in the UK."